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SEBI paves way for REITs in India

The idea of launching Real Estate Investment Trusts (REITs) in India has been in discussion for a long time. It was in cold freeze for a long time due to lack of clarity on taxation and the pass-through status. Recently in the Budget the Finance Minister Arun Jaitley has given pass-through status to these entities. After this SEBI has come up with its final regulations with major changes.

Potential: Experts see this move as a great potential to infuse funds in to the real estate industry. According to industry estimates the REITS and InvITs (Infrastructure Investment Trusts) have the potential to attract about Rs.1 lakh crore (Rs.1 trillion). This can bring in more capital to the cash-starved industries and help unlock capital from projects. When we come to the investor’s point of view REIT is more suited for high-networth individuals who seek stable yields. Currently REITs are a solution for real estate companies to raise funds, and not a nice investment opportunity for investors….sounds funny but that’s the reality, however, overtime this will emerge as an alternate asset class.

FAQ on REITS

This is not a comprehensive description, but just a quick summary of REITs to strengthen your understanding.

What is a REIT? REIT stands for Real Estate Investment Trusts. These are trusts that are designed to collect funds from various investors to invest in real estate assets. In India REIT would be a set up as a trust and registered with SEBI. It shall have parties such as Trustee, Sponsor(s) and Manager. This is similar to the structure of a mutual fund that we are familiar with.

What kind of properties will REITs invest in? In general each REIT (just like each mutual fund/scheme) would have a mandate to invest in particular segment or types of projects. This could be residential, commercial office, retail, other segments or a combination of these. But in India as of now REITs can invest only in commercial real estate assets, either directly or through SPVs (Special Purpose Vehicles). REIT should hold atleast 50% stake in those SPVs, and the SPVs in turn should hold atleast 80% of its assets directly in properties.

Initial Public Offers: For coming up with an initial offer to public the value of assets owned or proposed to be owned by the REIT should be atleast Rs.500 crore in value. The minimum size of the offer has to be Rs.250 crore. This would ensure that this option is made available to reputed real estate firms and companies with sizable financial resources.

Minimum Subscription Size: The initial subscription size of the offer will be Rs.2 lakhs. This means the initial offer would not attract small investors.

Listing: Units of REITs shall be mandatorily listed on a recognized Stock Exchange and REIT shall make continuous disclosures in terms of the listing agreement. Trading lot for such units shall be Rs 1 Lakh. Although the initial offer is not suited for small or medium-networth investors, the listed REITs could attract some mid-sized investors.

Sponsor Commitment: Sponsors should have 25% interest in units of REIT for 3 years from date of listing. After 3 years they shall hold 15% interest throughout the life of the REIT. This is to ensure that the sponsors have some skin in the game. Sponsors will be affected if the fund underperforms and they need to be responsible for the fund and serve the best interest of investors. There are other regulations on number of sponsors, which we will ignore for now.

Where can REITs invest?: The conditions for investment are below:-

  1. Not less than 80% of the value of REITs shall be in completed and revenue generating properties
  2. Not more than 20% of the value of REITs shall be invested in

    1. Developmental properties
    2. Mortgage backed securities
    3. listed/ unlisted debt of companies/body corporates in real estate sector
    4. equity shares of companies listed on a recognized stock exchange in India which derive not less than 75% of their operating income from Real Estate activity
    5. government securities
    6. money market instruments or Cash equivalents

Since atleast 80% goes in to completed properties that generate regular revenues the investor can be assured that the fund is earning regular revenues from the property.

The remaining 20% could go in to one of the six categories. If investment goes in to developmental (under construction) projects the risk is higher and the return potential is good too. For instance investors can participate in new projects whose price can go up substantially once the property is complete and handover to tenants.

Valuation: REIT, through a valuer, shall undertake full valuation on a yearly basis and updation of the same on a half yearly basis and declare NAV within 15 days from the date of such valuation/updation

Distribution of Cash Flows: REIT shall distribute not less than 90% of the net distributable cash flows, subject to applicable laws, to its investors, atleast on a half yearly basis. This is a good provision to ensure that investors get access to majority of the cash flows. For instance if the REIT has a cash flow of Rs.100 crore it has to mandatorily distribute Rs.90 crore to its investors. The decision of holding, delaying or reducing dividends has been curtailed. Since real estate assets are difficult to sell/liquidate, the cash flows are the only source of income in the short-term.

Will REITs succeed in India? The next obvious question is whether the REITs will get a good response from investors and become a popular investment avenue. Its too early to gauge the response. The initial guidelines have just enabled REITs for large investors and those who can invest Rs.1 lakhs (in case of listed REITS). Moreover the concept is new and there is hardly any track record to rely on. Although experts estimate commercial properties to provide 9-10% returns, one has to see if REITs can offer similar returns. Will the returns on REITs be higher than fixed deposits after deducting taxes? This question will decide the investor interest and response. Although initially REITs may provide lesser returns, the yields could go up when rental income increases, and this would provide steady increase in returns unlike other fixed instruments (such as FDs, bonds, etc.). Moreover, the initial REITs are meant for high-networth investors, so small investor participation cannot be gauged. These REITs invest in commercial properties only, but in global context there are other types of REITs that invest in residential, industrial and other projects. For a start, restricting this to commercial projects is a good move to test the market with large players before rolling it out to other segments. REITs will take some time to catch up and prove itself because returns from real estate would be moderate initially and it’s an illiquid asset class where one cannot sell properties to encash quick gains. The ultimate success would depend on how well the funds are run and how they meet the expectations of various stakeholders such as investors, developers, regulators, etc.

Funding Realty: The government feels these new investment avenues will reduce the pressure on the banking system and also make available fresh equity in the form of long-term finance from foreign and domestic sources, including non-resident Indians. This can provide an avenue for investors to participate in real estate with a smaller sum (Rs.1 lakh for listed REITs) rather than buying a property which can cost atleast Rs.30 lakhs or higher in large cities.

REITs can be a good way to get inflation adjusted returns and benefit from rental income and capital appreciation from property. This can also be a good avenue for investors looking for regular flow of income on their investments. Lets wait and see who launches the first REIT in India…hopefully this should happen by this Diwali or latest by December 2014!

Please share your comments and feedback or if you know the latest updates on REITs.

Sridhar

Founder of ElegantInvestor.in & Author of How to Create Wealth from Blue Chip Stocks

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